Reader Kevin sent the following question on restricted stock units:

I work for a Canadian branch of a U.S. company. As incentives, we receive both stock option grants and restricted stock units. Since tax season is drawing near, I’m trying to gain a full understanding of the tax implications of both of these awards.

I believe that stock options are essentially taxed as capital gains. Say you were granted options with a strike of $50 and you exercise 500 when the FMV is $100. Your gain is 500*($100-$50) = $25000, and that gets taxed as normal income but there is also some sort of deduction of 50% that makes that gain essentially the same as if it had been a capital gain? So you really only end up paying tax on $25000/2 = $12500?

I found the above info in the fourth paragraph of the section Taxable Income – Employee Security Options Deduction available here.

I wasn’t able to find any information at all regarding Canadian tax treatment of restricted stock units. To continue the example above, let’s say that 200 RSUs have vested and I’d like to sell them when the FMV is $100. The cost is zero, so the gain would be 200*$100 = $20000. But is that taxed as ordinary income or is there anything in place to give RSUs the same preferential tax treatment as options?

Thanks for the question because I had to search for information on restricted stock. Employee stock options work exactly as you describe. Employees are given an option to purchase company stock at a certain price subject to a vesting schedule. A common example of a vesting schedule would be 1/4 of the options vest (i.e. can be sold) in the first year and 1/48th of the initial grant vests every month thereafter.

Restricted stock awards (RSA), also called incentive stock awards, are shares granted in your name as of the date of grant and held in escrow. The shares are called “restricted” because they are subjected to a vesting schedule similar to stock option grants. The shares will not be restricted upon vesting allowing you to sell the shares.

Canadian tax treatment of stock options is favourable as you describe. There are no taxes owed when stock options are granted and only 50% of the stock option profits are taxable when you exercise. RSAs, on the other hand, are taxed at grant in Canada, which makes them unpopular because employees have to pay ordinary income tax on money then don’t yet have.

Restricted Stock Units (RSU) provides similar benefits as RSA but instead of actual shares, employees receive an opportunity to receive stock in the future. This article suggests that RSUs are not taxed at grant and my understanding (based on this article) is that when RSUs vest and are converted into company stock, the value of the stock at the time of vesting will be considered as ordinary income and taxed at your marginal rate. If you are a tax expert or have experience with RSU, I’d love to hear your comments.

This article has 14 comments

  1. Hahaha, I could have sworn I posted a similar comment in one of the threads — maybe at MDJ.

    I too work for a Canadian office of a US company and received a grant of 500 RSUs.

    125 vested recently, and I had to pay tax on that… it worked out to about 44% tax and seems to be considered income tax. I used the sell-to-cover option, which means almost half my shares were sold to pay off the taxes. The rest of the shares I was able to sell for a profit.

    Stock options are far superior… and unfortunately I joined the company too late as earlier employees got options. They stand to gain so much more because they also received more options, plus they save a lot in taxes.

  2. Canadian Capitalist

    Personally I’d rather have restricted stock than options. The trouble with options is that if they are underwater, they are worthless. RSUs are better because if the stock falls during the first year, at least there is some profit, albeit less than what you could have if the stock had gone up.

    Having said that companies tend to give out far fewer RSUs than options and if there is a profit, options are better from a tax point of view.

  3. Very true… haha. I only wish I had options because the company has done very well since I joined.

    Heck, I should have bought stocks when I joined… I have the benefit of hindsight of course. But I don’t like to lay all eggs in one basket (my employment, investments) — and of course, the limited trading windows.

  4. A follow up question on the 50% reduction on the stock option gain to make it similar to capital gains.

    In the document pointed to – http://www.fin.gc.ca/drleg/wmmNov06n_3e.html – it does not mention the “Canadian Controlled Private Corporation” part that I have seen elsewhere in various discussions of this topic – e.g. http://www.grantthornton.ca/taxtips/taxtips_template.asp?TipID=92

    If the company is US based but the employee is employed by the Canadian subsiduary (my situation too), does the 50% reduction really still apply against the profit gained from the stock options exercised? Or is the subsiduary considered a CCPC and thus the point is moot? Or can this CCPC point be ignored?

    Thanks for a particularly timely post and any follow up answer you can provide or point out!

  5. Canadian Capitalist

    Mike: Canadian subsidiaries of US companies probably won’t qualify as CCPC. You can simply ask your finance department if your employer is treated as a CCPC. In any case, you will pay tax on 50% of your stock option gains, if you exercise and sell immediately.

  6. Also, if you make charitable donations look at donating some of the proceeds of your stock option gains to charity and you will not only get the charitable deduction but you will also not have to pay the tax on the portion donated. Kind of a double benefit. Much better then donating with after tax dollars.

  7. The other advantage of options versus RSUs is that with options you can defer the taxable benefit until the shares are sold (http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/rprtng-ncm/lns101-170/101/scrty-eng.html).

    It’s not clear if the same holds for RSUs. Does anyone know?

    In my case, this would be especially useful if this were indeed the case. I have to pay taxes on RSUs that vested in 2008, and for which the FMV at vesting is twice as much as it is today. If I can’t defer, then it becomes a case of having to pay taxes on a paper benefit using money that I don’t have, even if I sell the shares.

  8. Pingback: New withholding taxes on stock option benefits | Canadian Capitalist

  9. Pingback: Tax Treatment of Restricted Stock Unit (RSU) Benefits | Canadian Capitalist

  10. Hi there, I appreciate the above questions and comments.
    I have a particular situation that is slightly different, and would love clarification. I work for the Candian division of a US based company that has awarded me RSUs, with varying vesting dates.
    My company however includes the FMV of the awarded units in the year it was granted, in my income statements at the end of the year.
    As the shares vest, (for ex. I had two grants awarded to me in 2010, that vested in 2013) I recieve release statments from the US stock holding company outlining a taxable compenstation for the vested stock.
    I dont have to claim the vested amount do I, as I already paid tax at the grant date??
    I am reading that this is only permitable under Restricted shares and not units, so I am confused.

    Thanks for any info in advance.
    Jared

    • Ram Balakrishnan

      @Jared: Sounds like the RSUs you were awarded work differently. I’ll have to investigate this and get back to you.

      • I have the same situation. On my statement there is a foreign NQ tax Rate of 24%, and the taxe code is CAN. Does that mean I already paid taxes ? How this should be reflected on my tax report ? Thanks

  11. I am in the same situation than nath, I assume 24% is the IRS tax rate, not the Canadian one. Will this mean we have to pay more after income tax?

  12. I was given RSU’s from my company. My position is being eliminated and I am taking a demotion. The company has advised me that I will only receive the vested portion of the stock. Do I have any rights to the total amount since I am staying on and not being laid off?